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United States Court of Appeals,
Fifth Circuit.
No. 94-10774.
In the Matter of SOUTHMARK CORPORATION, Debtor.
SOUTHMARK CORPORATION, Appellant,
v.
D. Vinson MARLEY, Appellee.
June 26, 1995.
Appeal from the United States District Court for the Northern
District of Texas.
Before LAY,1 DUHÉ, and DeMOSS, Circuit Judges.
DUHÉ, Circuit Judge:
Southmark Corporation, as debtor-in-possession, sought to
recover its $400,000 prepetition payment to D. Vinson Marley in an
adversary proceeding under Sections 547 and 548 of the Bankruptcy
Code. The bankruptcy court denied recovery after a bench trial.
Southmark appealed only the court's ruling on the § 547 preference
action. Utilizing clear error review, the district court affirmed.
We affirm as well.
BACKGROUND
Southmark and Marley signed an employment contract in 1982
that required Southmark to pay severance benefits in the event it
terminated the contract. In 1986, Southmark transferred all its
employees to North American Mortgage Investors, Inc. (NAMI), a
wholly owned Southmark subsidiary, which in turn leased them back
1Circuit Judge of the Eighth Circuit, sitting by
designation.
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to Southmark. On April 28, 1989, Southmark and Marley executed a
settlement agreement, and Marley received a check for $400,000. By
signing the agreement, Marley released all Southmark severance
obligations under the employment contract ($357,000) and agreed to
provide consulting services to Southmark for ninety days hence
($43,000). The check bore NAMI's name and was drawn on Southmark's
Payroll Account. The payor bank cleared the check on May 4, 1989.
Southmark filed for a Chapter 11 reorganization in bankruptcy
on July 14, 1989, and asserted this action to recover the $400,000
payment to Marley. In its preference cause of action, Southmark
alleged that the $357,000 payment of severance benefits was a
preference. On cross motions for summary judgment, the bankruptcy
court determined that Southmark had satisfied all the elements of
a preference except for whether the funds transferred to Marley
were property of the estate. In a ruling from the bench after
trial, the court denied the preference. The court held that the
transferred funds were not property of the estate because Southmark
failed to prove an interest in them. In addition, the court
applied the earmarking doctrine to hold that NAMI's payment to
Marley, to the extent that it released Southmark's liability to
him, merely substituted one creditor for another. As an alternate
holding, the court reconsidered its summary judgment ruling and
held that the transfer was not a preference because it was not on
account of an antecedent debt. Southmark contests the court's
three rulings on appeal.
DISCUSSION
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While this appeal was pending, we decided Southmark Corp. v.
Grosz, 49 F.3d 1111 (5th Cir.1995). Another Southmark preference
action, Grosz considered whether a Southmark subsidiary's check
drawn on Southmark's Payroll Account was property of Southmark's
estate. We answered that question in the affirmative. Id. at
1119. Consequently, Southmark argues here that Grosz controls the
property of the estate issue and requires reversal on that ground.
We need not address Grosz or the bankruptcy court's application of
the earmarking doctrine because we hold that the transfer was a
contemporaneous exchange therefore not avoidable as a preference.
In its summary judgment ruling, the bankruptcy court held that
Southmark established all the § 547(b) elements of a preference
with the exception of the property of the estate issue. The court
also denied Marley's contemporaneous exchange defense asserted
under § 547(c)(1). In its ruling after trial, however, the court
changed its mind. It determined that Southmark's debt arose when
it terminated Marley. Considering Marley's termination and the
transfer to have been simultaneous, the bankruptcy court concluded
that the transfer was not "for or on account of an antecedent
debt," which is an element of a preference.2 The district court
saw no error in the bankruptcy court's conclusion.
Southmark challenges the bankruptcy court's conclusion that
the debt was not antecedent with three alternative arguments.
2"[T]he trustee may avoid any transfer of an interest of the
debtor in property ... for or on account of an antecedent debt
owed by the debtor before such transfer was made...." 11 U.S.C.
§ 547(b)(2) (1988).
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First, Southmark contends that the debt arose in 1982 when
Southmark and Marley executed the employment contract. Second,
Southmark contends that it terminated Marley in mid-April 1989, not
on April 28. Third, even if the termination occurred on April 28,
Southmark argues that the transfer did not occur until May 4, when
the drawee bank paid the check.
A debt is antecedent under § 547(b) if the debtor incurs it
before making the alleged preferential transfer. In re
Intercontinental Publications, 131 B.R. 544, 549
(Bankr.D.Conn.1991); Tidwell v. AmSouth Bank (In re Cavalier
Homes), 102 B.R. 878, 885 (Bankr.M.D.Ga.1989); 4 Lawrence P. King,
Collier on Bankruptcy ¶ 547.05 (15th ed. 1995). Our focus,
therefore, is on the date the debt was incurred and the date the
transfer occurred. The determinations of these dates involve mixed
questions of law and fact, which we review de novo. See Barnhill
v. Johnson, 503 U.S. 393, 396-98, 112 S.Ct. 1386, 1389, 118 L.Ed.2d
39 (1992).
Southmark first contends that it incurred its debt when it
and Marley signed the employment contract that called for payment
of severance benefits in the event of termination. The Code
defines "debt" as "liability on a claim." 11 U.S.C. § 101(12)
(1988). A debtor incurs a debt when he becomes legally obligated
to pay it. In re Emerald Oil Co., 695 F.2d 833, 837 (5th
Cir.1983); see also Sherman v. First City Bank (In re United
Sciences of Am.), 893 F.2d 720, 724 (5th Cir.1990) (explaining, in
setoff context, that bank incurred debt when right to payment
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arose, not when bank asserted right).
Under the Code, a party to an executory contract has a claim
against the debtor only when the debtor has rejected the contract.
See 11 U.S.C. §§ 365(g), 502(g) (1988); Wainer v. A.J. Equities,
984 F.2d 679, 684-85 (5th Cir.1993) (per curiam). Consequently, a
debtor who breaches an executory contract incurs a debt only at the
time of breach. See Wainer, 984 F.2d at 685. Courts have reached
the same conclusion in preference actions. See In re Energy Coop.,
832 F.2d 997, 1002 (7th Cir.1987) (holding that purchaser incurred
debt when it anticipatorily repudiated contract to buy crude oil);
In re Gold Coast Seed Co., 751 F.2d 1118, 1119 (9th Cir.1985)
(holding that seed buyer became obligated to pay at time of
shipment, not when parties executed contract for future shipment).
In Intercontinental Publications, the debtor terminated an
employee whose employment contract provided for severance benefits
payable in installments after termination. The debtor brought a
preference action, and the bankruptcy court considered whether the
installment payments were on account of an antecedent debt. The
court held that the debtor incurred its debt when the debtor
terminated its employee. 131 B.R. at 550. Likewise, we conclude
that Southmark incurred its debt to Marley at the time it
terminated him.
The bankruptcy court found that Marley's termination occurred
simultaneously with the execution of the settlement agreement. We
review a bankruptcy court's factual findings for clear error, and
we adhere strictly to that standard of review when the district
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court has affirmed those findings. In re Young, 995 F.2d 547, 548
(5th Cir.1993). Southmark contends that Marley was terminated in
mid-April 1989, before the parties executed the settlement
agreement on April 28. As sole support of its contention,
Southmark cites the deposition of its Chief Executive Officer,
Arthur G. Weiss. Weiss's deposition testimony, however, does not
support Southmark's contention; instead, Weiss explained that the
settlement agreement provided payment to Marley in termination of
the employment contract. The bankruptcy court's finding is not
clearly erroneous.
Finally, Southmark contends, even if it incurred the debt on
April 28, that the transfer occurred on May 4 when the bank paid on
the check. Southmark cites Barnhill for the proposition that a
transfer by check occurs, for purposes of § 547(b), on the date of
honor, not the date of delivery. 503 U.S. at 400, 112 S.Ct. at
1391. Because Barnhill makes the date of transfer later than the
date Southmark incurred the debt, Southmark contends that the
transfer was on account of an antecedent debt. We agree.
Nevertheless, the transfer comes under the contemporaneous
exchange exception of § 547(c)(1).3 A contemporaneous exchange for
new value occurs when a debtor incurs a debt and pays it by check
at the same time, and the exchange is substantially contemporaneous
if the payor bank honors the check. In re Standard Food Servs.,
3The trustee may not avoid a transfer that was "(A) intended
by the debtor and the creditor to or for whose benefit such
transfer was made to be a contemporaneous exchange for new value
given to the debtor; and (B) in fact a substantially
contemporaneous exchange." 11 U.S.C. § 547(c)(1) (1988).
6

723 F.2d 820, 821 (11th Cir.1984); S.Rep. No. 95-989, 95th Cong.,
2d Sess. (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5874. In
other words, § 547(c)(1) treats the payment of a valid check as a
cash transaction. Southmark delivered the check, terminated
Marley, and received new value from the release on execution of the
settlement agreement. The payor bank then honored the check. We
conclude that the transfer is a contemporaneous exchange under §
547(c)(1) and, therefore, not avoidable as a preference.
CONCLUSION
For the foregoing reasons, the district court's judgment
affirming the bankruptcy court is AFFIRMED.

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